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When is a License Really a Franchise?

By Mario Herman, Esq.

There are a number of businesses that operate as a license when in fact the businesses are franchises. This article describes how to recognize a franchise masquerading as a license.

The Federal Trade Commission Franchise Rule, 16 C.F.R. 436.1 et seq., governs, at a federal level, disclosures which a “franchisor” must provide to each prospective franchise. There are also numerous state laws which may apply in any given situation. The discussion in this article will be limited to the requirements under the Franchise Rule.

Whether a continuing commercial relationship is a "franchise" under the Franchise Rule, is determined by whether the business relationship contains the three definitional elements of a "franchise" set forth in the Franchise Rule, and it does not matter what name the parties choose to assign to the relationship. 44 Fed. Reg. 49,966 (August 24, 1979). In other words, if it walks like a duck and quacks like a duck . . . .

Under the Franchise Rule, where the parties are in a continuing commercial relationship there are three definitional elements of a "franchise." The franchisor must:

  1. Promise to provide a trademark or other commercial symbol;

  2. Promise to exercise significant control or provide significant assistance in the operation of the business; and

  3. Require a minimum payment of at least $500 during the first six months of operations.

(16 C.F.R. Parts 436.2(a)(1)(i) and (2); 436.2(a)(iii)).)

Trademark

According to the FTC, a franchise entails "the right to operate a business that is "identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark." The term "trademark" is intended to be read broadly to cover not only trademarks, but any service mark, trade name, or other advertising or commercial symbol.

Significant Control or Assistance

The Franchise Rule covers business arrangements whereby the franchisor "will exert or has the authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation."

When Is Control or Assistance Significant? The more franchisees reasonably rely upon the franchisor’s control or assistance, the more likely the control or assistance will be considered "significant." Franchisees’ reliance is likely to be great when they are relatively inexperienced in the business being offered for sale or when they undertake a large financial risk. Similarly, franchisees are likely to reasonably rely on the franchisor’s control or assistance if the control or assistance is unique to that specific franchisor, as opposed to a typical practice employed by all businesses in the same industry. Further, to be deemed "significant," the control or assistance must relate to the franchisee’s overall method of operation – not a small part of the franchisee’s business.

Examples of significant types of control:

    • Site approval, site design or appearance requirements
    • Hours of operation
    • Production techniques
    • Accounting practices
    • Personnel policies
    • Promotional campaigns requiring franchisee participation or financial contribution
    • Restrictions on customers and area of operation.

Examples of significant types of assistance:

    • Formal sales, repair, or business training programs
    • Establishing accounting systems
    • Furnishing management, marketing, or personnel advice
    • Selecting site locations
    • Furnishing system wide networks and website
    • Furnishing a detailed operating manual.

 

Required Payment

The FTC interprets the term "payment" broadly, capturing all sources of revenue that a franchisee must pay to a franchisor or its affiliate for the right to associate with the franchisor, market its goods or services, and begin operation of the business. Required payments can go beyond a simple franchisee fee, entailing other payments that the franchisee must pay to the franchisor.

Examples of Required payments:

    • Initial franchise fee
    • Continuing royalties on sales
    • Advertising assistance
    • Equipment and supplies
    • Training
    • Security deposits
    • Non-refundable bookkeeping charges
    • Promotional literature
    • Equipment rental

Payments which, by practical necessity, a franchisee must make to the franchisor or affiliate also count toward the required payment. A common example of a payment made by practical necessity is a charge for equipment that can only be obtained from the franchisor or its affiliate and no other source.

Remedies Available to Purchasers of Disguised Franchises

Courts have held that the Franchise Rule does not provide a direct remedy to franchisees. However, actions have been brought against franchisors for violations of the Franchise Rule under state "little FTC acts," or unfair trade or business practices acts which incorporate the Federal Trade Commission Act. The remedies available under these acts vary from state to state. Some are limited to rescission and restitution, while others allow a plaintiff to be awarded damages, and in some case the trebling of damages, costs and attorneys’ fees. Additionally, it is important to remember that franchisees or persons, who entered into license agreements without proper disclosure, may have remedies under their respective states’ franchise laws. Such remedies can include rescission, actual damages, the trebling of damages, attorney’s fees, and costs of litigation.

Be sure to consult a seasoned Franchise Law Attorney or lawyer to determine if your "license" arrangement is, in fact, a disguised franchise (i.e., a "duck").

 

Mr. Herman, licensed in Washington, D.C., represents franchisees domestically and internationally in negotiation, mediation, arbitration, and litigation with their franchisors. He has practiced nationally and internationally for twenty five years, has an excellent reputation, and has very reasonable rates. He is available at www.franchise-law.com, and www.internationalfranchiselaw.com. His telephone number is 202-686-2886

 

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